DePaul UniversityDepartment of MarketingDriehaus College o.docx

DePaul University
Department of Marketing
Driehaus College of Business
Center for Sales Leadership
Procter & Gamble / Walgreens Case
Spring 2020
Your Distributor
McKesson's Roots in Health Care Services
McKesson is the world's oldest and largest health care services
company, providing pharmaceuticals, medical supplies and
technology solutions that improve the quality of health care
while reducing costs. McKesson people, products and solutions
touch every facet of the health care system - from physicians
and hospitals to pharmacies, payers and patients. This

connective role in health care enables them to drive innovation
and empower their customers to achieve their full potential.
The history of McKesson dates back to the beginnings of
organized health care in the United States. Founded in 1833 by
John McKesson and Charles Olcott in New York City, the
company was focused on the importation and wholesaling of
therapeutic drugs and chemicals from its inception.
Run out of a small shop in the city’s financial district, the
business quickly began to thrive in an era when sailing ships
were introducing America to a new world of global trade.
McKesson and Olcott did a brisk business stocking the medicine
chests aboard those ships, providing them with drugs imported
from Europe and medicinal herbs, roots and spices acquired
from Shaker colonies in Pennsylvania.
Soon the partners hired an assistant, Daniel Robbins, who
within a few years would be made a partner himself. After
Olcott’s death in 1853, the firm was renamed McKesson &
Robbins. By then, the company was already distributing
pharmaceutical products via covered wagons in 17 states and
territories, from Vermont to California. In 1855, the company
became one of the first wholesale houses to manufacture drugs.
McKesson & Robbins' fluid extracts, tinctures, pills and tablets
soon became known all over the world and the company won
medals for its pioneering work.
The 20th Century: Expanding Horizons
In the early 1900s McKesson & Robbins made a critical
strategic decision to persuade a number of well-established
wholesaling firms to become its subsidiaries, forming a national
drug wholesaling company. That move made McKesson &
Robbins the leading distributor of pharmaceutical drug products
in the United States. It also shifted the company's focus to

distribution for various lines of businesses outside of health
care.
During the 1960s, McKesson & Robbins continued its focus on
distribution by merging with Foremost Dairies of San Francisco
to form Foremost-McKesson Inc. The new company included
four main operating units: McKesson & Robbins Drug
Company, Foremost Foods Company, McKesson Liquor
Company and McKesson Chemical Company. Foremost-
McKesson became the largest U.S. distributor of drugs,
alcoholic beverages and chemicals; the largest supplier of whey
by-products; the largest producer of processed water; a leader in
the fresh dairy products field; and a multiregional distributor of
hospital and laboratory supplies and equipment.
In the 1980s and 1990s, McKesson decided to focus more on
health care and divested its unrelated businesses such as
Foremost Dairies, McKesson Chemical, McKesson Wine &
Spirits and Armor All Products.
During this time, McKesson acquired Automated Healthcare,
now part of McKesson Automation, and General Medical, the
largest distributor of medical-surgical supplies. The company
also acquired HBO & Company for $14 billion in stock and
operated for a time as McKesson HBOC—the world's largest
health care services company. In 2000, McKesson divested its
only remaining non-health care asset, McKesson Water
Products.
McKesson Today
Today, McKesson is ranked 15th on the FORTUNE 500 with
more than $106.6 billion in annual revenue. The company
delivers vital medicines, medical supplies and health care
information technology solutions that touch the lives of patients
in every health care setting. The depth and breadth of the
company’s product and service offerings, coupled with the
largest customer base in the health care industry, uniquely

position McKesson to meet the needs of its customers:
· 200,000 physicians
· 26,000 retail pharmacies
· 10,000 long-term care sites
· 5,000 hospitals
· 2,000 medical-surgical manufacturers
· 750 homecare agencies
· 600 health care payers
· 450 pharmaceutical manufacturers
McKesson Corporation, currently ranked 15th on the FORTUNE
500, is the nation’s largest health care services company.
McKesson is dedicated to helping its customers deliver high-
quality health care by reducing costs, streamlining processes
and improving the quality and safety of patient care. Over the
course of its 176-year history, McKesson has grown by
providing:
· Pharmaceutical supply management across the spectrum of
care
· Medical-Surgical supplies to non-acute care sites
· Health care information technology for hospitals, physicians,
homecare and payers
· Pharmacy automation
· Services for manufacturers and payers designed to improve
outcomes for patients
Empowering the evolution of health care, McKesson’s products
and services improve the quality of care, eliminate errors,
reduce unnecessary costs, synthesize information for
physicians, improve the workflow of nurses and free up
pharmacists to counsel patients.
Your Customer
America's premier pharmacy
How did a neighborhood drugstore, founded in 1901 and

measuring just 50 feet by 20 feet, become the pharmacy all
others are measured by and one of the most respected American
corporations?
It all started in a town called Dixon
It would be impossible to tell the story of Walgreens drugstores
without telling the story of Charles R. Walgreen, Sr. the man
who started it all. Walgreen was born near Galesburg, Illinois,
before his family relocated to Dixon, Illinois - a town 60 miles
north of his birthplace - when his father, a farmer turned
businessman, saw the great commercial potential of the Rock
River Valley. It was here that Walgreen, at the age of 16, had
his first experience working in a drugstore, though it was far
from a positive one. Working at Horton's Drugstore (for $4 a
week) was a job he took only because of an accident that left
him unable to take part in sports. While working in a local shoe
factory, Walgreen accidentally cut off the top joint of his
middle finger, ending his athletic competition. Were it not for
the accident, Walgreen might never have become a pharmacist,
business owner and phenomenally successful entrepreneur.
Ironically, his initial experience working at Horton's was itself
a failure. Walgreen left after just a year and a half on the job.
Still, Walgreen realized that his future lay not in Dixon, but in a
far larger city — Chicago.
Chicago in 1893, the year of Walgreen's arrival, was far from
promising for a future drugstore entrepreneur. More than 1,500
drugstores already competed for business (many extremely
successful) and customers had no lack of choice. Given this stiff
competition, Walgreen's ultimate achievements are all the more
remarkable.
A lesson well learned - and never forgotten - by Walgreen
In a series of jobs with Chicago's leading pharmacists - Samuel
Rosenfeld, Max Grieben, William G. Valentine and, most
importantly, Isaac W. Blood - Walgreen grew increasingly
knowledgeable - and increasingly dissatisfied - with what he
saw as old-fashioned, complacent methods of running a
drugstore. Where was the desire to provide superb customer

service? Where were the innovations in merchandising and store
displays? Where was the selection of goods that customers
really wanted and could afford? Where was the sense of trying
to understand, please and serve the many needs of drugstore
customers? And, most of all, where was the commitment to
providing genuine value to the customer?
The answer was obvious: Walgreen had to open his own
pharmacy.
However, it was not until 1901 that Walgreen was able to put
together enough money for the down payment on his pharmacy.
He wanted to buy the store in which he was working, owned by
Isaac Blood. Walgreen had been not only a trusted employee,
but a valuable business advisor as well. Yet even in view of
Walgreen's outstanding business counsel on Blood's behalf,
Blood was unyielding in the sale to Walgreen, raising his asking
price from $4,000 to $6,000. Though it would take years for
Walgreen to pay off the loan he signed for the purchase, he
went ahead. He was now his own man and well on his way to
building one of the most remarkable businesses in America.
By every account, Walgreen succeeded brilliantly, simply by
practicing what he preached and instituting what he felt were
clearly needed innovations. New, bright lights were installed to
create a cheerful, warm ambiance in the store. Each customer
was personally greeted by Walgreen or his colleague, Arthur C.
Thorsen. Aisles were widened, creating a spacious, airy,
welcoming feeling - a far cry from the cramped interiors of
other drugstores. The selection of merchandise was improved
and broadened, including pots and pans (unheard of in a
drugstore!) at the bargain price of 15¢ a piece! Prices were kept
fair and reasonable. The quality of Walgreen's pharmaceutical
compounds (he had become a registered pharmacist in 1897)
met the very highest standards for purity and freshness.
Efficiency was increased. But the most dramatic change
Walgreen instituted was a level of service and personal

attention unequaled by virtually any other pharmacy in Chicago.
The year was 1910. Walgreen now had two stores. His
challenge: how to find ever-new ways of satisfying a growing
customer base while outshining his competitors.
Over the preceding 100 years, the soda fountain had become key
to virtually every American drugstore. Beginning in the early
19th century, bottled soda water, and later charged soda water,
were considered important health aids, making it a natural
fixture in drugstores. Manufacturers vied in creating ornate
fountains, with onyx counter-tops and fixtures of silver and
bronze and lighting by Tiffany.
Walgreens® was no exception to such a popular trend. Indeed,
its soda fountains were among Chicago's most beautiful. Yet the
reality was that the items soda fountains served - ice cream and
fountain creations - were invariably cold. And cold items sold
only in hot weather. That meant each fall drugstore owners
everywhere were resigned to mothballing their soda fountains
until the warm weather returned. Thus, the drugstores lost an
important revenue stream, not to mention valuable store space
that could have been used for other, profitable purposes.
Why not serve hot sandwiches?
Beginning with simple sandwiches, soups and desserts,
Walgreen was able to keep his fountain open during the winter
and provide his customers with affordable, nutritious, home-
cooked meals. As a result of this common-sense innovation,
Walgreen once again demonstrated his knack for helping his
company while better serving the public. From then on, through
the 1980s, food service was an integral part of the Walgreens
story. Every Walgreens® was outfitted with comfortable,
versatile soda fountain facilities serving breakfast, lunch and
dinner. Just as Walgreen had reasoned, customers coming to the
stores for food usually stayed to purchase other necessary items.
And with its friendly waitresses, wholesome food and fair

prices, loyalty to Walgreens increased exponentially.
By 1913, Walgreens® had grown to four stores, all on Chicago's
South Side. The fifth Walgreens® opened in 1915 and the ninth
in 1916. By 1919, there were 20 stores in the rapidly-growing
chain.
As impressive as this growth was, even more impressive was the
superb management team that Walgreen had begun to assemble
since his second store opened. Walgreen would often say -
without any show of false modesty - that one of his greatest
talents was his ability to recognize, hire and promote people
that he considered smarter than he was. In his ability to spot
talent, Walgreen was rarely wrong. In fact, his uncanny ability
to hire extended even as far as the people who manned his soda
fountain, including the man who created Walgreen's next
sensation.
By 1920, now 20 stores strong and growing quickly,
Walgreens® was an established fixture on Chicago's retail
scene. Throughout this decade, Walgreens® underwent
phenomenal growth. By 1929, the total number of Walgreens®
stores reached 525, including locations in New York City,
Florida and other major markets. Many factors contributed to
this unprecedented growth: a superb management team, modern
merchandising, innovative store design, fair pricing,
outstanding customer service and exceedingly high pharmacy
quality and service. Yet, one can't overlook something that may
have seemed a minor innovation at the time. This was the
invention of Walgreens® immortal malted milkshake, an instant
classic, by Ivar "Pop" Coulson in 1922. Response could not
have been stronger if Coulson had found a cure for the common
cold! His luscious creation was adopted by fountain managers in
every Walgreens® store. It was written about in newspapers and
talked about in every city where there was a Walgreens®. But
most of all, it was the object of much adoration. It was not at all
unusual to see long lines outside Walgreens® stores and

customers stand three and four deep at the fountain waiting for
the new drink. Suddenly, "Meet me at Walgreens® for a shake
and a sandwich" became bywords as popular as "Meet me under
the Marshall Fields' clock" at State and Randolph in Chicago.
So, once again, Charles Walgreen's prediction that his soda
fountain would be absolutely essential to his stores as a source
of revenue, company growth and increased customer satisfaction
(which translated into even higher levels of customer loyalty
and patronage) came true. In its own way, Coulson's malted was
the fuel for Walgreens dramatic growth.
Surviving - and conquering - the Great Depression
By 1930, Walgreens® had well over 500 stores and quickly was
becoming the nation's most prominent drugstore chain.
Throughout this period, Walgreens® continued to innovate. It
had already become convinced of the value of advertising and
remained one of the biggest newspaper advertisers in Chicago
as well as other parts of the country. In fact, Walgreens® ran
the largest promotion campaign in its history - costing more
than $75,000 - during 1931. Perhaps even more significant was
Walgreens® entry into broadcast advertising. Also in 1931,
Walgreens® became the first drugstore chain in the country to
advertise on radio, with legendary Chicago Cubs announcer Bob
Elson as the "voice" of Walgreens ®.
Walgreens® expanded its line of high-quality, private label,
value-packed items, from sundries and over-the-counter
remedies to the hugely popular "Peau Doux" (pronounced "Po
Do") golf balls, talc and other products. As a result Walgreens®
saw consistent sales growth during the Depression years. In
fact, so confident was Walgreen of his country and his
company, he erected a brand-new building to serve as
Walgreens® state-of-the art warehouse/distribution center for

stores in the greater Chicago area.
From the 1940s to today, the story of Walgreens® is the story
of a company that has never rested on its laurels, finding ever-
new ways to satisfy its customers and stay ahead of the curve in
operating its business.
With Walgreen’s insistence on innovation and commitment to
customers, growth and prosperity lay ahead. By 1975, more than
1,500 pharmacists in 633 stores filled close to 30 million
prescriptions annually, four times the 7.5 million dispensed in
1962 and five million more than in 1972.
Walgreens® today
By 1984, Walgreens® opened its 1,000th store - and today, with
425 new stores opening each year and 7,000 planned by 2010,
Walgreens continues to innovate. Walgreens® new computer
system for filling prescriptions, Intercom Plus, links all stores
into a single network and represents how advanced technology
serves customers' needs better than any other pharmacy
resource. In fact, Walgreens® is the largest private user of
satellite technology (second only to the United States
government). Billing, labeling and prescription histories (for
tax planning and reimbursement) are available more quickly and
easily than ever before.
At the end of the 2009 fiscal year, Walgreens® reported annual
sales of $63.3 billion (up 7.3% from the prior year), and
earnings of $2.01 billion (down 7.3% from the prior year).
Prescriptions account for 66% of Walgreens sales.

Your Company
The World's Brand Expert
Since 1837, P&G has built a rich heritage of touching
consumers’ lives with brands that make life a little better every
day. This simple purpose has enabled them to become one of
the world’s leading consumer products companies—and will
continue to guide them as they seek to improve lives now and
for generations to come.
The Strength of P&G
P&G focuses on five core strengths required to win in the
consumer products industry:
Consumer understanding
No company in the world has invested more in consumer and
market research than P&G. P&G interacts with more than five
million consumers each year in nearly 60 countries around the
world, and conducts over 15,000 research studies every year.
P&G invests more than $350 million a year in consumer
understanding. This results in insights that tell them where the
innovation opportunities are and how to serve and communicate
with consumers.
Innovation
P&G is the innovation leader in our industry. Virtually all the
organic sales growth delivered in the past nine years has come
from new brands and new or improved product innovation. More
than half of all product innovation coming from P&G today
includes at least one major component from an external partner.

The IRI New Product Pacesetter Reportranks the best-selling
new products in our industry in the U.S. every year. Over the
past 14 years, P&G has had 114 top 25 Pacesetters—more than
their six largest competitors combined. In the last year alone,
P&G had five of the top 10 new product launches in the U.S.
and 10 of the top 25.
Brand-building
P&G is the brand-building leader of the industry. They have
built the strongest portfolio of brands in the industry with 22
billion-dollar brands and 19 half-billion-dollar brands. Eleven
of the billion-dollar brands are the #1 global market share
leaders of their categories. The majority of the firms are #2 in
their categories.
Go to Market Capabilities
P&G is consistently ranked by leading retailers in industry
surveys as a preferred supplier and as the industry leader in a
wide range of capabilities including clearest company strategy,
brands most important to retailers, strong business fundamentals
and innovative marketing programs.
Scale
Over the decades, P&G has established significant scale
advantages as a total company and in individual categories,
countries and retail channels. P&G’s scale advantage is driven
as much by knowledge-sharing, common systems and processes,
and best practices as it is by size and scope. These scale
benefits enable them to deliver consistently superior consumer
and shareholder value.
The P&G Brands
P&G's portfolio is led by 22 billion-dollar brands, focused in
three broad categories - Beauty and Grooming, Health and Well
Being, and Household Care. Brands in the billion dollar
category include:

Ariel® (laundry detergent)
Actonel® (osteoporosis drug)
Bounty® (paper towel), Braun® (small-appliances)
Crest® (toothpaste and teeth whitening)
Dawn® (dishwashing detergent)
Downy® (fabric softener)
Duracell® (batteries and flashlights)
Fusion® (men's wet shave razors)
Gain® (laundry detergent and fabric softeners)
Gillette® (safety razor and male grooming)
Head & Shoulders® (shampoo and conditioners)
Old Spice® (aftershave, deodorants, soaps and body wash)
Ivory® (soap)
Nice 'n Easy® (hair coloring)
Olay® (women's skin care)
Oral-B® (toothbrush and oral care)
Pampers® (disposable diaper and baby care)
Pantene® (hair care products)
Prilosec® (heartburn medicine)
Pringles® (potato chips)
Puffs® (facial tissue)
Secret® (antiperspirant and deodorant)
TAG® (deodorant and body spray)
Tide® (laundry detergent)
Vicks® (over-the-counter medicines - Formula 44®, Sinex®,
NyQuil®/DayQuil®)
Wella® (hair care products)
Whisper® (pantyliners)
Financial Results
Working hard to stay in touch with the consumers who use their
products, P&G reported sales of $79.0 billion (down 3.3% from
the prior year) and earnings of $13.4 billion (up 10.7% from the
prior year) in fiscal 2009.

The Challenge
The Vicks® NyQuil® and DayQuil® Cold and Flu Multi-
Symptom Relief products are the leading cold remedy product
sold in the US market and in many markets world-wide.
Winter means flu, and flu encourages sufferers to give their
colds to Contac®, or Dristan®, or NyQuil®, or Comtrex®,
along with other pills, tablets and liquids in the $5.0 billion
cold remedy market.
"This market is very dependent on the level of winter
nastiness,'' said Neil B. Sweig, an analyst at
Shearson®/American Express®. ''Last February-March, we had
widespread flu, and cold remedy sales in that period were up 21
percent. Now we are having a much colder December-January
this year than we had last year, and that bodes well for this
market.''
But, while cold remedies as a group have been outselling items
such as shampoo, toothpaste and aspirin individually for several
years, the industry has had trouble growing. Advertising
spending of more than $500 million a year has not been able to
result in significantly larger amounts of medication down the
throats of the afflicted.
''Based on research by A.C. Nielsen, 51% of consumers do not
use cold and flu products, because they cannot find their brand
in stock at the exact time that they need it - identical to the
percentage that do not keep a regular supply of cold and flu
products in their medicine cabinet inventory. If it is not readily
accessible, they will not purchase the products, since the cold
and flu are usually gone within three to seven days.'' said Mr.
Sweig.
''It's a marketing game,'' said Peter B. Robb, an analyst at
Merrill Lynch, Pierce, Fenner & Smith Inc. ''New improved
products, or product line extensions supported by heavy
advertising, are the ones that make the most headway.
In the scramble for market share, manufacturers have recently

introduced a number of new products - Vicks® Headway®, for
example - but none have enjoyed the spectacular success of
Comtrex®.
Comtrex®, a Bristol-Myers Company product, arrived on retail
shelves in the last quarter and propelled itself into third place
almost immediately, selling $750 Million within only a few
years.
But the undisputed leader in cold remedies is Richardson-Vicks
with its NyQuil®, a nighttime liquid cold medication, and its
line of Vicks® products. According to Mr. Robb, the company
has a market share of slightly more than 31 percent of the cold
remedy market, with sales last year of $1.55 Billion.
Close on its heels is Contac®, marketed by Menley & James, a
SmithKline® subsidiary, with about a $900 Million, Comtrex®
ranks third and No.4 is Dristan®, from American Home
Products Corporation, which has roughly 12 percent, according
to Mr. Sweig.
The remainder of the cold remedy market seems to be divided
between brands such as CoTylenol®, from the McNeil
Consumer Products division of Johnson & Johnson, and Alka-
Seltzer Plus® Cold Medicine from Miles Laboratories (with a
10% and 5% share respectively), as well as private-label brands
from major drugstore chains.
Sharply defined marketing trends have emerged since the entry
of Comtrex®, which was the first remedy to carve out a multi-
symptom relief niche.
''Comtrex® looked at an untapped market and found people who
wanted to take one pill that would clear up their noses and
throats and sinuses all at once,'' said Mr. Sweig, at
Shearson/American Express®.
Comtrex® was introduced with a network television ad
campaign that showed a medicine cabinet spilling over with
pills and bottles on one side, and a lone container of Comtrex®
on the other. The ads worked and others (including NyQuil®)
quickly picked up on the multi-symptom approach.
In comparison, Contac®, with its time-release capsules, staked

out its territory in 1961 and has owned it ever since. ''There are
no significant competitors to Contac® in the sustained release
field,'' said William P. Howe 3d, vice president and director of
marketing for Menley & James.
It remains to be seen whether the new entries will open up more
of the market, or simply steal market share from their
predecessors. ''There's an increasing trend toward self-
medication, as doctors' fees and prescription drug prices have
risen enormously over the past 10 years,'' said a spokesman at
Richardson-Vicks, citing a 141 percent rise in prescription drug
prices over the past ten years. ''New entries create additional
competition, but they also help expand the market.''
In a strategy meeting with the marketing department, you (as
VP of Sales for P&G's Health and Well Being - Worldwide)
have pointed out three critical areas which limit P&G's ability
to gain maximum benefit from the cold and flu season onset
every year:
· Knowing when the cold/ flu season starts (and its severity) in
specific areas
· Time lag between start, consumer reaction, retailer orders, and
advertising
· Time lag between retailer shipment, and in-store display
placement
You have recommended this year that the company test a special
promotion to supplement the normal pre-ordering and shipments
with your largest account - Walgreens® - using a special "Just
in Time" distribution effort to provide incremental sales and
margin during the season, which would consist of the following
steps:
· Engage the Gallup® organization to set up an "early-bird"
warning system with public schools which would compensate
the schools $1,000 per month (3 schools in each of the top 100

markets) for a period of 3 months to report absenteeism (flu-
days) on a weekly basis. This data would be used to trigger
additional display shipments to retailers, as well as initiate pre-
planned higher levels of television advertising on a market-by-
market basis.
· Engage McKesson to stock and supply special displays prior to
the season, which can then be delivered in 24 hours to key retail
locations. P&G would ship the product 30 days in advance of
the expected season to McKesson, and would provide terms of
Net 60 days from date of shipment to Walgreens® stores.
McKesson would be paid a fixed percentage of the retailer cost
of the display of 10% for storage, distribution, shipping, and
set-up under the program.
· Engage Walgreens® to commit in advance to automatic orders
to be placed and shipped at the start of the season for special
displays (over their normal seasonal stocking levels), and
commit to multiple displays for a period of 60 days. P&G
would provide terms of 60 days from date of shipment from
McKesson to the retailer on the displays, as well as a 5%
discount on the display merchandise only.
The season sales history of NyQuil® indicates that roughly 70%
of the sales occur in the 1st (Jan-Mar and 4th (Oct-Dec) period,
and the remainder "off-season". Your early talks with retailers
indicated that they feel that they can increase sales by 25% in
the 6 month period over normal levels if they have a timelier in-
stock situation, as well as higher consumer awareness at the
appropriate time.
The special display will feature the following products in the
NyQuil® and DayQuil® brands:

In an earlier meeting with one of the Walgreens® buyers, you
shared the following initial analysis of the pricing and gross
margin positions for both Walgreens® and P&G® related to the
specific details of the promotion.
The only products which will be in the special display are
NyQuil® in liquid (single and
double pack), and NyQuil®/DayQuil® LiquiCaps (double pack)
as follows:
NyQuil®NyQuil®NyQuil®/DayQuil® Combo
Product Description(10oz)(2-10oz)40 Count LiquiCaps
Retail price (SRP)$7.09$13.59$12.69
Retailer cost of goods$4.99$9.69$8.85
Retailer gross margin29.6%28.7%30.26%
Vick's cost of goods$1.15$2.40$2.75
Vicks gross margin77.0%75.2%68.9%
Number of each per display7214484
Additional expense for special$25.00/display
NyQuil® cardboard shipping
carton and in-store display
(P&G pays this cost)
In order to provide an incentive to Walgreens® for taking on
the additional merchandise and pre-committing to take at least
three displays per store per month during the season (9 per
store), P&G® is offering Walgreens® the special Net 60-day
terms and the 5% discount from the normal prices on the display
merchandise. No return goods will be allowed at the end of the

season, as Walgreens® can "break-up" the displays and place
the merchandise on the shelf - since they already stock and sell
these items all year long.
Additionally, as compensation for the stocking and shipping of
the displays, McKesson® will be paid 10% of the retailer cost
of goods on each display to cover stocking, storage, and final
shipping and display set up at the store level.
During another presentation of this new program to Walgreens®
yesterday, you shared the initial financials with four more
influencers/customer contacts (all of whom you have had some
contact with in the past):
· Charles Schultz – Category Manager
· Frank Novello – Pharmacy Manager, Health Outcomes and
Reports
· Julie Heart – Promotions Manager
· Fred Grayda – Financial Analyst
You were fortunate to have a new intern with you during the
presentation who took notes of the conversations. From his
notes, it appears Walgreens® is interested in the promotion, but
needs to better understand the details of the programs and how
it will impact their margins and operation. The people in this
meeting had not seen the initial financial proposal that you
quickly reviewed with the other buyer so there were a number
of questions. Based on the feedback from these four, you have
set up another meeting with them next week to present the final
proposal to Walgreens®. The meeting is only six days away,
but you and your P&G® sales and marketing colleagues are
used to creating winning presentations that monetize your
marketing strategy with tight timing.
Transcript from yesterday’s meeting with Walgreens®:

You:Good morning! It's a pleasure to see you all again, and I
appreciate you taking time out to discussa new promotion with
Walgreens® for Vicks® NyQuil® and DayQuil® for this cold
and flu season.
Charles:We appreciate the fact that you want to partner with
Walgreens® to test this promotion, and are anxious to hear
more - especially since a number of the people in this meeting
have not heard all of the details.
We've got some aggressive sales targets from management this
year, and we need all the help we can get to increase revenue
and profit in our stores.
As you know, the pharmacy section generates nearly two-thirds
of our profit at Walgreens®.
If you can show us a way to increase our profitability and sales
levels over last year, we're interested - we've just been put on
an entirely new bonus system - and it's based on increases over
last year on a store-by-store basis in profit margin.
You:Frankly, I'm here to get your reactions, rather than a firm
commitment today - so that we can come back to you with a
custom designed idea which meets your needs - and we would
like to hear your thoughts on the value of display promotions -
pro and con - from each of your individual responsibility areas.
Frank:Good idea - frankly they're (excuse my language) a "real
pain in the ass". We never seem to get the needs right, they
take up an enormous amount of space in the distribution center,
and we always seem to get "stuck" with too much inventory at
the end of the promotion that we don't normally carry. Then we
have to sell if off at a discount. I just don't see the upside from
a special promotion from our standpoint, especially since our
last one bombed, and I really got chewed out for not being able
to deliver the product to the stores on time.

You:I certainly understand the distribution problems. If I'm
hearing you right, a promotion which would eliminate handling
through your distribution center would be the best outcome for
your group?
Frank:Frankly, yes - but I don't know what others on the team
feel about that concept.
Julie:As Promotions Manager, it goes a little deeper than that -
we need to have displays of only the highest share products,
since we don't want to end up with excess inventory - and on a
seasonal basis, the money that we have to tie up pre-season is
huge in
terms of the amount of inventory that we have to carry to ensure
that we are ready when the season starts.
I'm concerned that we'll have a disaster like last year, when we
promoted the new product from American Home Products.
Since the consumers were not aware of it, we had that product
all the way through June, when we had paid for it in October.
Since I'm responsible for the store display and promotion
program, I'll definitely need to see the probability of
incremental sales and margin at the store level. And it can't
include any items that we don't carry - too many companies see
one-time promotions as a way to add SKU's to the store.
Fred:One of the things that we'll want to see is the ROI on the
promotion. Since finance has intruded on the art of promotions
in our company, we have to give them numbers for everything.
As the finance member of this buying team, I will definitely
need to see that before we can approve anything. I need a way
to make the financial guys happy!
You:Since this is a test, it will be limited to Walgreens® for
this first season - does that have additional appeal?
Charles:Absolutely - as you know, we're the best drugstore

chain in America - but we need better promotions. Osco Drug
always seems to have great promotions, and I'm pretty damned
tired of being second to them in this area!
Julie:I actually like the idea, and think it will greatly increase
our sales by keeping us in stock, but I don't want to be the one
to tell management that the promotion left us with a ton of
product at the end of the season! I think that we would be smart
to exclude the 20% of stores that had a poor performance last
season due to the fact that they are in warmer climates that do
not have the dramatic temperature change. I'm pretty proud of
the work we've done this year, and wouldn't want it to end in a
disaster.
Frank:If you can show me how you can do it without involving
the distribution centers - I'm on your side. Frankly, I'm pretty
upset about the promotions group always thinking that
our space and capacity for shipping is unlimited.
You:Our initial market research has shown some very
interesting data regarding when and why people purchase cold
and flu products, and I'll review that with you at the next
meeting.
Thanks to you, I think that we've got some good ideas to help
you increase your sales and margin, while limiting the risk and
pain that usually comes with short term promotions.
I know that you are all anxious to look at the final sales and
margin impact of the test program, and see the operating details.
I'll get right on the analysis required to demonstrate the value of
this promotion to your bottom line! We’ll be back next
Wednesday to
present the details.

2
3
Chapter 11Ross, Westerfield, Jaffe, and Jordan's Spreadsheet
MasterCorporate Finance, 11th editionby Brad Jordan and Joe
SmoliraVersion 11.0Chapter 11In these spreadsheets, you will
learn how to use the following Excel functions:The following
conventions are used in these spreadsheets:1) Given data in
blue2) Calculations in redNOTE: Some functions used in these
spreadsheets may require that the "Analysis ToolPak" or "Solver
Add-In" be installed in Excel.To install these, click on the File
tabthen "Excel Options," "Add-Ins" and select"Go." Check
"Analysis ToolPak" and "Solver Add-In," then click "OK."
SQRT/xl/drawings/drawing1.xml#'Section%2011.2'!A19
COVAR/xl/drawings/drawing1.xml#'Section%2011.2'!A84
CORREL/xl/drawings/drawing1.xml#'Section%2011.2'!A84
Adding a
trendline/xl/drawings/drawing1.xml#'Section%2011.8'!A34
Regression
estimates/xl/drawings/drawing1.xml#'Section%2011.8'!A43
SLOPE/xl/drawings/drawing1.xml#'Section%2011.8'!A108
INTERCEPT/xl/drawings/drawing1.xml#'Section%2011.8'!A108
Section 11.2Chapter 11 - Section 2Expected Return, Variance,
and CovarianceIn Chapter 10, we used the AVERAGE, VAR,
and STDEV functions to calculate the average, variance, and
standard deviation for historical returns. Unfortunately, Excel
does not have built-in functions that handle unequal
probabilities, so we need to create our own
equations.Supertech(1)
State of
Economy (2)
Probability of

State (3)
Return if State
Occurs (4)
Product
(2) × (3) (5)
Deviation from
Expected Return
(3) - E(R) (6)
Squared Value
of Deviation (7)
Product
(2) × (5) Depression0.25-
0.20Recession0.250.10Normal0.250.30Boom
Joe Smolira: Notice that we used the equation 1 - C9 - C10 -
C11 instead of entering a probability directly. The reason we
did this is that since the probabilities must sum to one, we
cannot make an error in data entry and have a higher or lower
sum.
0.50Expected return =Variance =The standard deviation is the
square root of the variance, so the standard deviation
is:Standard deviation:RWJ Excel TipExcel has a built-in
function, SQRT, that finds the square root of a number. SQRT is
found under the Math & Trig tab. The function looks like
this:We should also note that the square root (or any other
power) can be calculated using the caret key (^). For example,
we could have entered an equation as H13^(1/2).And for
Slowpoke:Slowpoke(1)
State of
Economy (2)
Probability of
State (3)
Return if State
Occurs (4)
Product

(2) × (3) (5)
Deviation from
Expected Return
(3) - E(R) (6)
Squared Value
of Deviation (7)
Product
(2) × (5) Depression0.05Recession0.20Normal-
0.12Boom0.09Expected return =Variance =Standard
deviation:To calculate the covariance and correlation, we need
to calculate the product of the return deviations, multiply this
product by the probability of the state of the economy, and then
sum to find the covariance. Doing so, we find:
State of
Economy
Probability of
State Deviation of
Supertech Return from the
Expected ReturnDeviation of
Slowpoke Return from the
Expected ReturnProduct of the
DeviationsProbability of
State of the
Economy times
Product of the
DeviationsDepressionRecessionNormalBoomCovariance =Since
the correlation is the covariance divided by the product of the
standard deviations, the correlation between Supertech and
Slowpoke is:Correlation:Covariance and Correlation with
Historic DataWhile we just discussed the calculation of
covariance and correlation using unequal probabilities, both
calculations are often done using historic market data. When
using historic data, Excel has built-in functions that will
calculate the covariance and correlation for you.Suppose we
have the following returns for the market and a
stock:YearMarket returnStock

return118%7%227%25%35%21%413%4%5-17%-16%66%19%7-
21%-38%834%29%919%15%1011%16%What is the covariance
and correlation of the returns between this stock and the
market?Covariance:Correlation:RWJ Excel TipThe functions for
covariance (COVAR) and correlation (CORREL) are both
located under More Functions, Statistical. Both functions use
similar inputs, namely the arrays that the data is located.To use
COVAR and CORREL, select the first data array, tab to Array2,
and select the second data array. It is irrelevant which data
array you select first. That is, the correlation between A and B
is equal to the correlation between B and A.A Quick Statistics
ReviewCovariance and correlation are measures of how much
two variables move together. If two variables tend to vary
together (that is, when one of them is above its expected value,
then the other variable tends to be above its expected value
too), then the covariance and correlation between the two
variables will be positive. On the other hand, when one of them
is above its expected value the other variable tends to be below
its expected value, then the covariance and correlation between
the two variables will be negative.
The main difference between covariance and correlation is the
interpretation. Covariance is an unstandardized number. A large
covariance can arise because the variance of the two variables is
large, or because of a strong relationship between the two
variables. Thus, the only interpretation we can take from the
covariance is the direction, either positive or
negative.Correlation is standardized and will be between -1 and
1. The closer the correlation is to -1, the stronger the negative
relationship between the variables, and the closer the
correlation is to 1, the stronger the positive relationship
between the two variables. Therefore, correlation measures both
the direction and magnitude of the relationship between two
variables.Correlation and DiversificationSo why is correlation
important to diversification? Correlation (and covariance)
measure how two assets move together. All else the same, the

lower the correlation between two assets, the greater the
diversification benefit. If you think of two assets with a
negative correlation, as one asset has a return above its average,
the other asset will have a return below its average. This will
smooth out the returns of a portfolio of these two assets.
However, if the assets have a positive correlation, as one asset
has a return above its mean, the other asset will also have a
return above its mean, so there is less benefit to diversification.
For an application, think of GM and Ford. Both are auto
manufacturers and would be expected to have a high correlation
because many of the firm specific risks that would affect GM
also affect Ford. However, GM is less likely to share firm
specific risk with Microsoft, so we would expect GM and
Microsoft to have a lower correlation than GM and Ford, and
therefore have a greater diversification benefit.
Section 11.4Chapter 11 - Section 4The Return and Risk for
PortfoliosIn the textbook, the equation for the standard
deviation of a portfolio is presented. Given the following
information concerning two stocks, what is the expected return
and standard deviation of the portfolio?Stock AStock
BExpected return9%14%Standard deviation19%55%Weight of
stock30%Correlation0.10The expected return and standard
deviation of the portfolio are:Expected return:Standard
deviation:Of course, we could be interested in examining the
opportunity set for the two assets. To see this, we can create a
table for various portfolio weights and then graph the results.
The expected return and standard deviation of the two assets for
various portfolio weights is:Weight of Stock AExpected
ReturnStandard
Deviation0.30.00.00%5%10%15%20%25%30%35%40%45%50
%55%60%65%70%75%80%85%90%95%100%So what does the
opportunity set for these two assets look like? Below, you will
see. To examine how a change in the correlation will affect the
shape of the opportunity set, change the correlation in the cell
above.So how do we find the minimum variance portfolio? The
best way is to use Solver. Try this for yourself and see if you

don't agree that the weight of Stock A in the minimum variance
portfolio is about 92.93%
Opportunity Set of Two Assets
Risk (Standard Deviation of Portfolio's Return)
Total Return on Portfolio
Section 11.8Chapter 11 - Section 8Market EquilibriumIn this
section, you will learn how beta is estimated. Before we begin
that discussion, we want to start with a graph of actual stock
returns. On the next tab, you will find the month end values for
the S&P 500, a common proxy for the market as a whole, and
the adjusted closing price for Amazon.com stock over a 60
month period. When estimating beta, 60 monthly returns is a
commonly used number of historical returns. Since we are going
to be using a statistical process to estimate beta, we would like
as much data as possible. However, the further back in time we
go, the less the company is like the current company. For
example, with AT&T, we could get stock prices for more than
100 years. But is AT&T in its current form actually comparable
to AT&T in 1930? Not really. For this and other reasons, 60
monthly returns has become relatively standard when estimating
beta.To begin, we would like to graph the returns of
Amazon.com stock against the returns of the S&P 500. In this
case, we used a scatter plot which resulted in the graph
below.Notice that we have added a trend line in this graph. This
trend line is called the characteristic line. The slope of this line
represents how the stock's returns respond to the market returns.
The slope of this line is the beta of the stock.RWJ Excel TipTo
add a trend line to a chart, do the following:1) Click anywhere
in the chart. This displays the Chart Tools, adding the Design,
Layout, and Format tabs.2) On the Layout tab, in the Analysis
group, click Trend line.3) You can use any of the predefined
options. Note that on the chart there is an equation. We went to
More Options and selected the box to display the equation on
the graph. We will have more to say about this equation
later.The equation in the graph above is a linear regression. We
can use the trend line option on a graph to estimate a linear

regression, but Excel has a tool that will estimate a linear
regression as well as give us more statistical information about
the regression estimate.RWJ Excel TipTo estimate a linear
regression, go to the Data tab, Data Analysis, and select
Regression, then OK.The input box for our linear regression
looks like this:The Y input range is the dependent variable, in
this case the stock returns, and the X input range is the
independent variable, or market return. We included the row
above the data and selected the Labels box, which will put a
label on the output for the variables. Finally, we selected the
Confidence Interval box and asked for a 90 percent confidence
interval. The output for this regression is below.SUMMARY
OUTPUTRegression StatisticsMultiple R0.5086032951R
Square0.2586773118Adjusted R Square0.2458958862Standard
Error0.0696275499Observations60ANOVAdfSSMSFSignificanc
e
FRegression10.09811632370.098116323720.23853353620.0000
333749Residual580.28118375090.0048479957Total590.379300
0746CoefficientsStandard Errort StatP-valueLower 95%Upper
95%Lower 95.0%Upper
95.0%Intercept0.005200840.009370240.55503807790.58100299
38-0.01355573330.0239574134-0.01355573330.0239574134X
Variable
11.08563210210.2413199114.49872576810.00003337490.60257
781691.56868638730.60257781691.5686863873More
RegressionIf you are just interested in the slope and intercept
for a regression, Excel has functions that will calculate these
values separately, SLOPE and INTERCEPT.Beta
(slope):Intercept:RWJ Excel TipBoth the SLOPE and
INTERCEPT functions are located under More Functions,
Statistical. The inputs for each function are the Y values and the
X values. Below, you will see the inputs we used for our results.
Performance of Amazon.com Stock and the S&P 500: Single
Index Model
S&P 500 Return
Amazon.com Return

Return DataReturn DataDateS&P
500Amazon.com12/31/091115.10$ 134.52S&P
500Amazon1/4/101073.87$ 125.412/1/101104.49$
118.403/1/101169.43$ 135.774/1/101186.69$
137.105/3/101089.41$ 125.466/1/101030.71$
109.267/1/101101.60$ 117.898/2/101049.33$
124.839/1/101141.20$ 157.0610/1/101183.26$
165.2311/1/101180.55$ 175.4012/1/101257.64$
180.001/3/111286.12$ 169.642/1/111327.22$
173.293/1/111325.83$ 180.134/1/111363.61$
195.815/2/111345.20$ 196.696/1/111320.64$
204.497/1/111292.28$ 222.528/1/111218.89$
215.239/1/111131.42$ 216.2310/3/111253.30$
213.5111/1/111246.96$ 192.2912/1/111257.60$
173.101/3/121312.41$ 194.442/1/121365.68$
179.693/1/121408.47$ 202.514/2/121397.91$
231.905/1/121310.33$ 212.916/1/121362.16$
228.357/2/121379.32$ 233.308/1/121406.58$
248.279/4/121440.67$ 254.3210/1/121412.16$
232.8911/1/121416.18$ 252.0512/3/121426.19$
250.871/2/131498.11$ 265.502/1/131514.68$
264.273/1/131569.19$ 266.494/1/131597.57$
253.815/1/131630.74$ 269.206/3/131606.28$
277.697/1/131685.73$ 301.228/1/131632.97$
280.989/3/131681.55$ 312.6410/1/131756.54$
364.0311/1/131805.81$ 393.6212/2/131848.36$
398.791/2/141782.59$ 358.692/3/141859.45$
362.103/3/141872.34$ 336.374/1/141883.95$
304.135/1/141923.57$ 312.556/2/141960.23$
324.787/1/141930.67$ 312.998/1/142003.37$
339.049/2/141972.29$ 322.4410/1/142018.05$
305.4611/3/142067.56$ 338.6412/1/142058.90$ 310.35
Master it!Chapter 11 - Master it!The CAPM is one of the most
tested models in Finance. When beta is estimated in practice, a
variation of CAPM called the market model is often used. To
derive the market model, we start with the CAPM:E(Ri) = Rf +

b[E(RM) - Rf]Since CAPM is an equation, we can subtract the
risk-free rate from both sides, which gives us:E(Ri) - Rf =
b[E(RM) - Rf]This equation is deterministic, that is, exact. In a
regression, we realize that there is some indeterminate error.
We need to formally recognize this in the equation by adding
epsilon, which represents this error:E(Ri) - Rf = b[E(RM) - Rf]
+ eFinally, think of the above equation in a regression. Since
there is no intercept in the equation, the intercept is zero.
However, when we estimate the regression equation, we can add
an intercept term, which we will call alpha:E(Ri) - Rf = ai +
b[E(RM) - Rf] + eThis equation, known as the market model, is
generally the model used for estimating beta. The intercept term
is known as Jensen's alpha and represents the excess return. If
CAPM holds exactly, this intercept should be zero. If you think
of alpha in terms of the SML, if the alpha is positive, the stock
plots above the SML and if alpha is negative, the stock plots
below the SML.a.You want to estimate the market model for an
individual stock and a mutual fund. First, go to
finance.yahoo.com and download the adjusted prices for the last
61 months for an individual stock and a mutual fund, and the
S&P 500. Next, go to the St. Louis Federal Reserve website at
www.stlouisfed.org. You should find the FRED® database on
this website. Look for the 1-Month Treasury Constant Maturity
Rate and download this data. This will be the proxy for the risk-
free rate. When using this rate, you should be aware that this
interest rate is the annual interest rate, while we are using
monthly stock returns, so you will need to adjust the 1-month T-
bill rate. For the stock and mutual fund you select, estimate the
beta and alpha of the stock using the market model. When you
estimate the regression model, find the box that says Residuals
and check this box when you do each regression. Because you
are saving the residuals, you may want to save the regression
output in a new worksheet.1) Are the alpha and beta for each
regression statistically different from zero? 2) How do you
interpret the alpha and beta for the stock and the mutual fund?
3) Which of the two regression estimates has the highest R

squared? Is this what you would have expected? Why?b.In part
a, you asked Excel to return the residuals of the regression,
which is the epsilon in the regression equation. If you remember
back to statistics, the residuals are the linear distance from each
observation to the regression line. In this context, the residuals
are the part of each monthly return that is not explained by the
market model estimate. The residuals can be used to calculate
the appraisal ratio, which is the alpha divided by the standard
deviation of the residuals.1) What do you think the appraisal
ratio is intended to measure?2) Calculate the appraisal ratio for
the stock and the mutual fund. Which has a better appraisal
ratio?3) Often, the appraisal ratio is used to evaluate the
performance of mutual fund managers. Why do you think the
appraisal ratio is used more often for mutual funds, which are
portfolios, than for individual stocks?
Solution
Master it!

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